A. SOURCES OF TAX LAW
Legislative- Congress (primary sourceà IRC) Title 26 of U.S.C. This class is Subtitle A only. Legislative history: bills, hearings, committees, debates
Executive- IRS & treasury- IRS= bureau w/in treasury dept that produces:
1) treasury regulations- interpret IRC (invalid if inconsistent w/ IRC)
2) Revenue rulings- dictate tax consq of transactions- guidance on specific fact patterns; issued to public at large
3) revenue procedure
4) private letter ruling- guidance request on consq; issued only to specific taxpayer, no one else can rely on
3 courts that interpret code and regulations and create judicial doctrine (in addition to code):
1) U.S. Tax Ct.
a) most common court
b) TP not have to pay tax to bring in ct- only court where can get into w/o paying up front
c) no jury (only judge- so more knowledge about tax)
2) U.S. District Ct
a) get jury trial
b) refund tribunals
c) must pay tax and ask for it back from IRS then bring suit
3) U.S. Claims Ct
a) no jury
b) must pay tax before bring suit
B. OVERVIEW OF COURSE
1. TAX LIABILITY= Tax rate (1(a) based on taxable income) x Tax base (à TI= GI – deduc)
2. BIG PICTURE:
GI- certain deductions= AGI
AGI- Personal Exemptions- either Standard or Itemized deduction= Taxable Income
Taxable Income X Tax Rate- Tax Credits= Tax Due or Refund
3. GROSS INCOME- §61
GI includes all income from whatever source derived including (list 15 items)- 61(a). Income from compensation, dividends, gains from dealings in pp, and discharge of debt are common types, but other code sections exclude certain type of income
1.61-1(a) GI includes income realized in any form (money, pp, services)
1.61-2(d)(1) if services are paid in exchange for other services, the FMV of such other services taken in payment must be included in income as compensation. (pp, services, etc).
Only include appreciation of stock when it is realized- “realization event” (sell, exchange)
sale of stock are included in GI as gains made – 61(a)(3)
Every time you have an expense you think is deductible, you must find a specific Code section authorizing the deduction. Two types of deductions available in computing taxable income:
1) Deduction from GI in computing AGI (AL)
2) Deductions from AGI in computing TI- TP subtract PE and then take larger of either SD or ID (BL)
§162(a) allows deduction of ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.
depreciate any equipment as a deduction over time and not all at once 1.263(a)-2(a) -167-8. Methods of depreciation: 1) allocate over life of property 2) first year more
Personal expenses- not deductible 262 (commuting cost/ personal mtg. payments) 1.162-2(e) and 1.262-1(b)(5)
Exception- “qualified resident interest” on personal debt (mtg) is deductible under 163(a)
You can deduct expenses paid or incurred “for the production of collection of income” 212(1) (not 162). 61a(4) interest and (7) divided- can’t reduce interest and dividends
This includes a management fee for investment activity, however 62 limits only certain types of 212 expenses to above the line and mngmt fee is not one of them.
General sales taxes are not deductible under 164 or 262, but if bus exp- it would be deductible
Real pp/ State and local taxes are deductible under 164(a)(1) and are taken below the line.
Estimated state income tax payment made that year is deductible under 164(a)(3) (below line), but cash method taxpayers can’t deduct the actual state income tax liability until pay the balance owing-so deduct next year
Charitable Contributions- deductible under 170(a)(1), but170(b)(1)(A) limits deduction to 50% of “contribution base.” 170b(1)(F) defines contrib. base as AGI. So long as AGI of twice amnt donate then entitled to the full deduction for the charitable contribution.
Deduction v. Credit: deduction reduces liability, amount save depends on tax rate; Credit reduces tax rate dollar for dollar by crediting to tax liability (Ex. 5K to church, 1,500 less to govt; 3,500 what get)
5. ADJUSTED GROSS INCOME
62: AGI= GI – certain deductions (62 not a deduc granting provision-only gives def)
2 categories of deductions:
1) above the line (62)- those used in determining AGI- allowed to all TPs regardless if itemize
trade or business- rent, wages, office supplies, deprec on equipment, not mngmt fee
2) below the line- only use after AGI been determined- taken only if the taxpayer itemizes
6. TAXABLE INCOME
Formula depends on if itemize deductions (claim below line deductions rather than std deduc)
If NOT itemize, only get std deduct in place of any below the line deductions (other than pers exp)
If below line deduction exceeds std deduct (3.07)(63c2) à should itemize 63(d)(def for itemiz deduc)
ITEMIZE- TI= GI- allowable deductions 63(a)
Section 67(a): 2% floor on Misc ID- this section says certain itemized deductions can’t be deducted unless the aggregate deduction exceeds 2% of the AGI. Higher income people (higher AGI) are not taking deduction as much because mean need more expenses.
Rationale= To get more taxes: increase tax rate, increase tax base, decrease misc deductions
Identify misc 67(b) + compare to 2% of AGI
Not subject to 67: home mtg interest, state income tax, real pp tax & charitable contrib. 67(b)
Subject to 67: bank mngmt fee
Section 68: Overall Limits- otherwise allowed item deduct are reduced by 3% of the amount by which the AGI exceeds an inflation-adjusted “applicable amount (68(b)(1))” (or if lesser, the reduction is 80% of otherwise allowable itemized deductions) 68(a). See table 3.08
Personal Exemptions: 151-
Number of people= (b) TP and spouse (c) dependents
Inflation adjusted personal exemption amount 151(d)= 3K for 2002 151(d)(4) & 3.11
Exemption rate can be reduced by 2% points for each $2,500 the AGI exceeds a specified, inflation-adjusted “threshold amount.” 151(d)(3)(a). On 2002 joint returnsà threshold is 206K (151(d)(3)(c), 4(B))(see table 3.11) .
If AGI is less than threshold amnt, the exemption is NOT reduced. If exceed amntàd3a reduce by applicable percentage. 2% for every 2,500 AGI exceeds threshold amnt.
In joint returns, since there are 2 TP then 2 personal exemptions 1.511-1(b)
Even if don’t itemize are entitled to claim personal exemptions in addition to std deduc
7. TAX RATE 1(a)
Base Tax amnt + (interest X amnt in excess over a certain amnt)
Capital Gains- 1(h) provides preferential tax rates for net capital gain that vary based on the tax payers bracket and on the components of net capital gain. See Capital Gain definition 1222(11).
Credits: 31- withholding taxes paid throughout the year by employers on behalf of the employees
Any estimated tax payment made (self-employed)- deducted from their tax liability figure
Child Tax Credit: 24- up to $600 per child (increase to 1K in 2010)- but phased out of AGI
Marginal Rate of Tax- highest rate of tax to which they are subject (here 30%)- any extra dollar made is taxed at 30%
Effective Rate of Tax- avg amnt paying of tax= Amnt tax owe divide by amnt of taxable income
8. FORMULA: what the tax rate applied to (tax base): Taxable income- 63(a) X Tax rate
C. GROSS INCOME: Analysisà 61, GG, 1.61, specific code provision
Definition:“Except as otherwise provided (possible exclusions), GI means all income from whatever source derived, including (but not limited to) the following items: [(1) – (15) of section 61(a) list 15 items specifically included in GI.] Reg 1.61-1(a) reiterates the broad construction of GI in section 61(a), providing in part: GI includes income realized in any form, whether in money, pp, or services.
2(d) compensation in exchange for services, “w/o services transfer would not have occurred”
Note Assumption: all income from whatever source derived, is GI, UNLESS explicitly excluded.
Income from all sources is taxed unless TP can point to an express exemption. This broad language was used to extert full measure of Congress’ taxing power under 16th A.
Three Elements to Establish GI:
A. Is it GI?
1. Standard for Income: Glenshaw Glass:
i) AW: Accession of wealth
ii) CR: Clearly realized
· Must have some realization event (must get for free)
· Different from recognition event
iii) CD: over which TP have complete dominion over
2. Policy: Congress intended in enacting 61 intended to “exert the full measure of taxing power.” “All income” means broad and just b/c not included not mean counted.
B. How much?
FMV or Price paid
if services paid for in ppà FMV of pp is the measure of compensation2(d)(1)
if paid for in form of servicesà value of the services received is amount of compensation
1. When is income actually received by TP
2. Method of Accounting
1) Cash Method- must actually or constructively receive money to include in GI. 1.446 (c)
Arg- should include b/c already provided service, asset of right to get paid
2) Accrual Method- claim income at moment earned by providing services
Treasure Trove- is gross income in year reduced to undisputed possession (1.61-14) Reasoning: If piano sold before found out about money, could not later have a claim to money under the law of treasure trove. Title belongs to finder as against all except TO. (theory- received economic benefit)
Include in GI:
a) Compensation Income: 61(a)(1) GI includes compensation for services, including fees, commissions, fringe benefits and similar items. (+ Reg 1.61-2(a)(1)). Amnt is cash received or FMV of pp/services received. Bonuses and Tips are also included in GI- 61(a)(1) + Reg 1.61-2(a)(1). Ex. Amnts given to clergy for marriage is GI.
Appreciation of stock does NOT constitute income to be realized.
Borrowing of money and pledging of the stock as security likewise does NOT constitute realization b/c non-realization event
3. Destruction of stock certificate
Not disposition of the ownership, but merely a destruction of a piece of paper-
Cottage Savings- need for exchanged properties to be “materially different”
Occurs when transfers the stock to creditor to satisfy a debt which generates gain which must be reported. It is just as though sold the stock and then paid creditor
D. OBLIGATION TO PAY
1) obligation to repay=no GIà no obligation to repay= GI
2) claim of right
1. LOANS (TP favor)
a. Argue could be loan- money received, but must be returned later: 1) repay and 2) payment
b. when receive loan proceeds= NO GI b/c loan not an “accession to wealth” or increase TP’s net worth b/c loan proceeds include an offsetting liability: TP obligation to repay the loan.
c. Repayment= no GI b/c repayment offset by creditor’s return of note and debtor receiving note is offset by repayment.
d. advance payment- argue AP could be involved (IRS favors)
1. Look at parties intent when $ transferredà rights, obligations (to give back), control over $
2. Argue AP= GI in yr of receipt. Glenshawà key to dominion is whether TP has some guarantee that he will be allowed to keep the money. Paid in advance + not loan company
AP protect against the risk the purchaser will back out of the deal before the seller performs and the dep received provided no such protection. Fact dep applied to amnt owed was a matter of customer choice, not proof of advance payment- no spec amnt.
3. Advance rentals, cancellation payments- included in GI the year received, regardless of the period covered or TP’s method of accounting.
4. GI includes include royalties from books, stories, play, trademarks etc. Reg. § 1.61-8(a)
5. An amnt received by a lessor from a lessee for canceling a lease constitutes GI for the year in which it is received, since it is essentially a substitute for rental payments. Reg. § 1.61-8(b)
6. expenditures by lessee are additional rental income to the lessor, if expenditures constitute in whole or part, a substitute for rent. Reg. § 1.61-8(c)
2. DEPOSITS: Security Deposits
a. Deposit: treated as loan= no GI. Say lack dominion over the deposits received. There is an obligation to refund and it’s w/in control of lessor (customer). Not treat as income at time of receipt, but dep carried on books as current liabilities, income not recognized until mailed monthly bill and if deposit used to offset.
b. Factors: control had to retain deposit, commingling of funds, frequent application of deposit
c. deposits v. AP
1. AP= Need dominion over customer deposits to qualify as taxable income at the time made
2. D= Amnts like loan from customer to co. Long as kept records when intermingled funds is ok.
3. Design rental agreement: 1) AP for rent and no obli to give back b/c co control over deposit v. 2) deferà deposit and get back b/c customer has dominion and not co.
4. Deposit Ex. D required elec deposit and when customer terminated its service, it could either pay the entire bill and receive refund of deposit or apply deposit to final bill. D not include deposits in GI when received and IRS says should have included (AP). The amnt deposited by customers were deposits and excluded from GI of IPL. (Indianapolis Power & Light Co)
5. Deposit Ex. residents of apts had to pay entry fee + one month rent before occupy. Applied IPL to rentà like K, said residents had rt to a refund of portion of fess and were w/in residents’ control and other had no unfettered dominion over money. Refundable portions weren’t AP for services or rent. (Highland Farms)
3. CLAIM OF RIGHT: Receipt of Money- report all year 1, deduct year 2 (if sep years)